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The Time Series of the Cross Section of Asset Prices

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  • Lior Menzly
  • Tano Santos
  • Pietro Veronesi
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    Abstract

    In this paper we propose a general equilibrium model that successfully reproduces the historical experience of the cross section of US stock prices as well as the realized history of the market portfolio. The model achieves this while addressing traditional concerns in the asset pricing literature: A high equity premium and volatility of returns, the long horizon predictability, and a low volatility of the risk free rate. The model combines a rich payoff structure with a habit persistence discount factor, which allows us to identify the effect on prices of idiosyncratic cash flow shocks versus business cycle components.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9217.

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    Date of creation: Sep 2002
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    Handle: RePEc:nbr:nberwo:9217

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    1. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    2. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
    3. Karen E. Dynan, 2000. "Habit Formation in Consumer Preferences: Evidence from Panel Data," American Economic Review, American Economic Association, vol. 90(3), pages 391-406, June.
    4. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report 280, Federal Reserve Bank of Minneapolis.
    5. Ferson, Wayne E. & Constantinides, George M., 1991. "Habit persistence and durability in aggregate consumption: Empirical tests," Journal of Financial Economics, Elsevier, vol. 29(2), pages 199-240, October.
    6. A. Abel, 2010. "Asset prices under habit formation and catching up with the Jones," Levine's Working Paper Archive 1395, David K. Levine.
    7. Tano Santos & Pietro Veronesi, 2001. "Labor Income and Predictable Stock Returns," NBER Working Papers 8309, National Bureau of Economic Research, Inc.
    8. David A. Chapman, 1998. "Habit Formation and Aggregate Consumption," Econometrica, Econometric Society, vol. 66(5), pages 1223-1230, September.
    9. Lettau, M. & Uhlig, H., 1995. "Can Habit Formation be Reconciled with Business Cycle Facts?," Discussion Paper 1995-54, Tilburg University, Center for Economic Research.
    10. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
    11. Heaton, John, 1993. "The Interaction between Time-Nonseparable Preferences and Time Aggregation," Econometrica, Econometric Society, vol. 61(2), pages 353-85, March.
    12. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
    13. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
    14. Boudoukh, Jacob & Richardson, Matthew & Whitelaw, Robert F, 1994. " Industry Returns and the Fisher Effect," Journal of Finance, American Finance Association, vol. 49(5), pages 1595-1615, December.
    15. Detemple, Jerome B & Zapatero, Fernando, 1991. "Asset Prices in an Exchange Economy with Habit Formation," Econometrica, Econometric Society, vol. 59(6), pages 1633-57, November.
    16. Heien, Dale & Durham, Cathy, 1991. "A Test of the Habit Formation Hypothesis Using Household Data," The Review of Economics and Statistics, MIT Press, vol. 73(2), pages 189-99, May.
    17. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    18. Tuomo Vuolteenaho, 2002. "What Drives Firm-Level Stock Returns?," Journal of Finance, American Finance Association, vol. 57(1), pages 233-264, 02.
    19. Tobias J. Moskowitz & Mark Grinblatt, . "Do Industries Explain Momentum?," CRSP working papers 480, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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    Cited by:
    1. Fernandez, Pablo & Aguirreamalloa, Javier & Liechtenstein, Heinrich, 2009. "The equity premium puzzle: High required equity premium, undervaluation and self fulfilling prophecy," IESE Research Papers D/821, IESE Business School.
    2. Longstaff, Francis & Piazzesi, Monika, 2002. "Corporate Earnings and the Equity Premium," University of California at Los Angeles, Anderson Graduate School of Management qt3qn115m4, Anderson Graduate School of Management, UCLA.
    3. Malcolm Baker & Jeffrey Wurgler, 2004. "Investor Sentiment and the Cross-Section of Stock Returns," NBER Working Papers 10449, National Bureau of Economic Research, Inc.
    4. Pierre Perron & Tatsuma Wada, 2005. "Let’s Take a Break: Trends and Cycles in US Real GDP," Boston University - Department of Economics - Working Papers Series wp2009-006, Boston University - Department of Economics, revised Feb 2009.

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